UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

(Mark One)

þ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2004.

or

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ____________ to ____________

Commission File Number: 1-16095

Aetna Inc.

(860) 273-0123

Not Applicable

     Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. þ  Yes    o  No

     Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).     þ  Yes    o  No

     Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

TABLE OF CONTENTS

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

CONSOLIDATED STATEMENTS OF INCOME

See Condensed Notes to Consolidated Financial Statements.

Page 1

CONSOLIDATED BALANCE SHEETS

See Condensed Notes to Consolidated Financial Statements.

Page 2

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

(1)

Net of reclassification adjustments (Refer to Note 7)

See Condensed Notes to Consolidated Financial Statements.

Page 3

CONSOLIDATED STATEMENTS OF CASH FLOWS

See Condensed Notes to Consolidated Financial Statements.

Page 4

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. Organization

The accompanying consolidated financial statements include Aetna Inc. (a Pennsylvania corporation) (“Aetna”) and its subsidiaries (collectively, the “Company”). The Company’s operations include three business segments: Health Care, Group Insurance and Large Case Pensions. Health Care consists of health and dental plans offered on both a risk basis (where the Company assumes all or a majority of the risk for health and dental care costs) and an employer-funded basis (where the plan sponsor, under an administrative services contract (“ASC”), and not the Company, assumes all or a majority of this risk). Health plans include health maintenance organization (“HMO”), point-of-service (“POS”), preferred provider organization (“PPO”) and indemnity benefit products. Health plans also include a consumer-directed plan that combines traditional POS or PPO coverage, subject to a deductible, with a benefit account, allowing members greater flexibility. The Group Insurance segment includes group life insurance products offered on a risk basis, as well as group disability and long-term care insurance products offered on both a risk and an employer-funded basis. Large Case Pensions manages a variety of retirement products (including pension and annuity products) primarily for defined benefit and defined contribution plans. These products provide a variety of funding and benefit payment distribution options and other services. The Large Case Pensions segment includes certain discontinued products (refer to Note 8 for additional information).

These unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America and include the accounts of Aetna and subsidiaries that the Company controls. All significant intercompany balances have been eliminated in consolidation. Certain reclassifications have been made to the 2003 financial information to conform to the 2004 presentation.

These interim statements necessarily rely heavily on estimates, including assumptions as to annualized tax rates. In the opinion of management, all adjustments necessary for a fair statement of results for the interim periods have been made. All such adjustments are of a normal, recurring nature. The accompanying consolidated financial statements and condensed notes should be read in conjunction with the consolidated financial statements and related notes presented in Aetna’s 2003 Annual Report on Form 10-K. Certain financial information that is normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America, but that is not required for interim reporting purposes, has been condensed or omitted.

2. Summary of Significant Accounting Policies

New Accounting Standards

Accounting for Variable Interest Entities (“VIE”)

In January 2003, the Financial Accounting Standards Board (“FASB”) issued Interpretation No. 46, Consolidation of Variable Interest Entities (“FIN 46”). This interpretation requires the Company to consolidate a VIE if the entity meets certain criteria and the Company is considered the primary beneficiary of the VIE. In December 2003, the FASB issued a revision to Interpretation No. 46, Consolidation of Variable Interest Entities (“FIN 46-R”). FIN 46-R amended certain provisions of FIN 46 and delayed implementation for entities that are not considered special purpose entities until the first quarter of 2004 with early adoption permitted. The Company adopted the provisions of FIN 46-R as of December 31, 2003. The adoption of FIN 46-R did not have a material impact on the Company’s financial position or results of operations. (Refer to Note 2 to the consolidated financial statements in Aetna’s 2003 Annual Report on Form 10-K.)

Page 5

Disclosures of and Accounting for Other-than-Temporary Impairments of Certain Investments

In March 2004, the FASB’s Emerging Issues Task Force (“EITF”) concluded its discussion of Issue No. 03-01, The Meaning of Other-Than-Temporary Impairments and Its Application to Certain Investments (“EITF 03-01”). EITF 03-01 provides accounting guidance regarding the determination of when an impairment (i.e., fair value is less than carrying value) of debt and marketable equity securities and investments accounted for under the cost method should be considered other-than-temporary and recognized in earnings. EITF 03-01 also requires annual disclosures of certain quantitative and qualitative factors of debt and marketable equity securities classified as available-for-sale or held-to-maturity that are in an unrealized loss position at the balance sheet date, but for which an other-than-temporary impairment has not been recognized. The disclosure requirements of EITF 03-01 were effective December 31, 2003. The accounting guidance of EITF 03-01 will be effective in the third quarter of 2004 and is not expected to have a material affect on the Company’s financial statements.

Stock-Based Compensation

At March 31, 2004, the Company had various stock-based employee incentive plans, which are described more fully in Note 14 to the consolidated financial statements presented in Aetna’s 2003 Annual Report on Form 10-K. The Company uses the intrinsic value method of accounting for stock-based awards granted to employees. Accordingly, compensation cost is not recognized when the exercise price of an employee stock option equals or exceeds the fair value of the stock on the date the option is granted. The following table illustrates the pro forma net income and pro forma earnings per share as if the Company had applied the fair value based method of accounting to all awards of stock-based employee compensation.

Page 6

3. Earnings Per Common Share

A reconciliation of the numerator and denominator of the basic and diluted earnings per common share (“EPS”) for the three months ended March 31, 2004 and 2003 is as follows:

(1)		Options to purchase shares of common stock for the three months ended March 31, 2004 of 1.9 million shares (with exercise prices ranging from $77.50 to $89.25) were not included in the calculation of diluted earnings per common share because the options’ exercise prices were greater than the average market price of common shares during such period.
(2)		Options to purchase shares of common stock for the three months ended March 31, 2003 of .6 million shares (with exercise prices ranging from $43.56 to $54.21) were not included in the calculation of diluted earnings per common share because the options’ exercise prices were greater than the average market price of common shares during such period.

4. Operating Expenses

For the three months ended March 31, 2004 and 2003, selling expenses (which include broker commissions, the variable component of the Company’s internal sales force compensation and premium taxes) and general and administrative expenses were as follows:

5. Other Acquired Intangible Assets

Other acquired intangible assets at March 31, 2004 and December 31, 2003 were as follows:

Page 5

Annual pretax amortization for other acquired intangible assets over the next five calendar years is estimated to be as follows:

6. Investments

Investment securities at March 31, 2004 and December 31, 2003 were as follows:

Net investment income includes amounts related to experience-rated contractholders of $40 million and $43 million for the three months ended March 31, 2004 and 2003, respectively. Interest credited to contractholders is included in current and future benefits on the Consolidated Statements of Income.

Net realized capital gains related to experience-rated contractholders of $8 million and $14 million for the three months ended March 31, 2004 and 2003, respectively, were deducted from net realized capital gains as reflected on the Consolidated Statements of Income, and an offsetting amount is reflected on the Consolidated Balance Sheets in policyholders’ funds.

7. Accumulated Other Comprehensive Income (Loss)

Changes in accumulated other comprehensive income (loss) related to changes in net unrealized gains on securities (excluding those related to experience-rated contractholders and discontinued products) were as follows:

(1)		Pretax net unrealized holding gains arising during the period were $130.0 million and $44.9 million for the three months ended March 31, 2004 and 2003, respectively.
(2)		Pretax reclassification adjustments for gains and other items included in net income were $18.7 million and $17.2 million for the three months ended March 31, 2004 and 2003, respectively.

8. Discontinued Products

The Company discontinued the sale of its fully guaranteed large case pension products (single-premium annuities (“SPAs”) and guaranteed investment contracts (“GICs”)) in 1993. Under the Company’s accounting for these discontinued products, a reserve for anticipated future losses from these products was established and is reviewed by management quarterly. As long as the reserve continues to represent management’s then best estimate of expected future losses, results of operations of the discontinued products, including net realized capital gains and losses, are credited/charged to the reserve and do not affect the Company’s results of operations. The Company’s results of operations would be adversely affected to the extent that future losses on the products are greater than anticipated and positively affected to the extent that future losses are less than anticipated. The current reserve reflects management’s best estimate of anticipated future losses.

Page 8

The factors contributing to changes in the reserve for anticipated future losses are: operating income or loss, realized capital gains or losses and mortality gains or losses. Operating income or loss is equal to revenue less expenses. Realized capital gains or losses reflect the excess (deficit) of sales price over (below) the carrying value of assets sold and any other-than-temporary impairments. Mortality gains or losses reflect the mortality and retirement experience related to SPAs. A mortality gain (loss) occurs when an annuitant or a beneficiary dies sooner (later) than expected. A retirement gain (loss) occurs when an annuitant retires later (earlier) than expected.

At the time of discontinuance, a receivable from Large Case Pensions’ continuing products equivalent to the net present value of the anticipated cash flow shortfalls was established for the discontinued products. Interest on the receivable is accrued at the discount rate that was used to calculate the reserve. The offsetting payable, on which interest is similarly accrued, is reflected in continuing products. Interest on the payable generally offsets the investment income on the assets available to fund the shortfall. At March 31, 2004, the receivable from continuing products, net of related deferred taxes payable of $109 million on the accrued interest income, was $380 million. At December 31, 2003, the receivable from continuing products, net of related deferred taxes payable of $106 million on accrued interest income, was $375 million. These amounts were eliminated in consolidation.

Results of discontinued products for the three months ended March 31, 2004 and 2003 were as follows (pretax, in millions):

(1)

Amounts are reflected in the March 31, 2004 and 2003 Consolidated Statements of Income, except for interest earned on the receivable from continuing products, which was eliminated in consolidation.

Page 9

Assets and liabilities supporting discontinued products at March 31, 2004 and December 31, 2003 were as follows (1):

(1)		Assets supporting the discontinued products are distinguished from assets supporting continuing products.
(2)		Includes debt securities on deposit as required by regulatory authorities of $129.6 million and $121.8 million at March 31, 2004 and December 31, 2003, respectively. These securities are considered restricted assets and were included in long-term investments on the Consolidated Balance Sheets.
(3)		The receivable from continuing products is eliminated in consolidation.

At March 31, 2004 and December 31, 2003, net unrealized capital gains on debt securities are included above in other liabilities and are not reflected in consolidated shareholders’ equity. The reserve for anticipated future losses is included in future policy benefits on the Consolidated Balance Sheets.

The reserve for anticipated future losses on discontinued products represents the present value (at the risk-free rate at the time of discontinuance, consistent with the duration of the liabilities) of the difference between the expected cash flows from the assets supporting discontinued products and the cash flows expected to be required to meet the obligations of the outstanding contracts. Calculation of the reserve for anticipated future losses requires projection of both the amount and the timing of cash flows over approximately the next 30 years, including consideration of, among other things, future investment results, participant withdrawal and mortality rates and the cost of asset management and customer service. Since 1993, there have been no significant changes to the assumptions underlying the calculation of the reserve related to the projection of the amount and timing of cash flows.

The projection of future investment results considers assumptions for interest rates, bond discount rates and performance of mortgage loans and real estate. Mortgage loan cash flow assumptions represent management’s best estimate of current and future levels of rent growth, vacancy and expenses based upon market conditions at each reporting date. The performance of real estate assets has been consistently estimated using the most recent forecasts available. Since 1997, a bond default assumption has been included to reflect historical default experience, since the bond portfolio increased as a percentage of the overall investment portfolio and reflected more bond credit risk, concurrent with the decline in the commercial mortgage loan and real estate portfolios.

The previous years’ actual participant withdrawal experience is used for the current year assumption. Prior to 1995, the Company used the 1983 Group Annuitant Mortality table published by the Society of Actuaries (the “Society”). In 1995, the Society published the 1994 Uninsured Pensioner’s Mortality table which the Company has used since then.

The Company’s assumptions about the cost of asset management and customer service reflect actual investment and general expenses allocated over invested assets.

Page 10

The activity in the reserve for anticipated future losses on discontinued products for the three months ended March 31, 2004 was as follows (pretax):

9. Debt

Under the terms of its revolving credit facilities, the Company is required to maintain a minimum level of shareholders’ equity, excluding net unrealized capital gains and losses, as of each fiscal quarter end. At March 31, 2004, the Company met its required minimum level of approximately $5.5 billion. The Company is also required to maintain its ratio of total debt to consolidated earnings as of each fiscal quarter end at or below 3.0. For this purpose, consolidated earnings equals, for the period of four consecutive quarters, net income plus interest expense, income tax expense, depreciation expense, amortization expense, certain excluded charges taken on or before December 31, 2003 and any extraordinary gains or losses. The Company met this requirement at March 31, 2004. Refer to Note 15 to the consolidated financial statements presented in Aetna’s 2003 Annual Report on Form 10-K for a description of the Company’s revolving credit facilities and more detail on the above mentioned covenants.

10. Capital Stock

On December 5, 2003, the Board of Directors authorized a share repurchase program for the repurchase of up to 10 million shares of common stock (not to exceed an aggregate purchase price of $750 million). The Company repurchased approximately 5.1 million shares of common stock at a cost of approximately $424 million. Approximately 5.0 million shares of common stock at a cost of approximately $419 million were repurchased during the first quarter of 2004. At March 31, 2004, approximately $55 million of these repurchase transactions were settled in early April.

On January 30, 2004, the Board of Directors’ Committee on Compensation and Organization approved a grant to employees of approximately 3.6 million stock options to purchase common shares of the Company at $77.50 per share. The January 30, 2004 grants will be fully vested by December 31, 2004. During the first quarter of 2004, the Company issued approximately 4.9 million shares of common stock for benefit plans, including approximately 4.4 million shares related to stock option exercises.

Under the Aetna Inc. Employee Stock Purchase Plan (the “ESPP”), 6.2 million of the Company’s common shares are reserved for issuance at March 31, 2004 in accordance with the ESPP’s provisions. Employee contributions are accumulated for a six-month period and used to purchase stock at the end of the offering period. A six-month accumulation period commenced on January 2, 2004. This accumulation period ends on June 18, 2004, and the purchase price for this offering will be at a 10% discount from the lesser of the stock’s fair market value on January 2, 2004 or June 18, 2004.

11. Dividend Restrictions and Shareholders’ Equity

Under regulatory requirements, as calculated at March 31, 2004, the amount of dividends that may be paid through the end of 2004 to Aetna by its domestic insurance and HMO subsidiaries without prior approval by state regulatory authorities is approximately $416 million in the aggregate. There are no such restrictions on distributions from Aetna to its shareholders. At March 31, 2004, the combined statutory surplus of the Company’s domestic insurance and HMO subsidiaries, reflecting intercompany eliminations, was $4.0 billion. At December 31, 2003, such surplus was $3.8 billion.

Page 11

12. Benefit Plans

Defined Benefit Pension Plans

Components of the net periodic benefit cost of the Company’s noncontributory defined benefit pension plan for the three months ended March 31, 2004 and March 31, 2003 were as follows:

Other Post-Retirement Benefit Plans

In January 2004, the Company amended the post-retirement dental plan to eliminate the dental subsidy for all retirees. As a result of this 2004 amendment, the Company recorded a curtailment benefit of approximately $32 million pretax in the first quarter of 2004 reflected in operating expenses (other general and administrative expenses). Refer to Note 14 to the consolidated financial statements presented in Aetna’s 2003 Annual Report on Form 10-K for additional information.

On December 8, 2003, the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the “Act”) was signed into law. The Act expands Medicare, primarily by adding a voluntary prescription drug benefit for Medicare eligible individuals starting in 2006. The Act provides employers currently sponsoring prescription drug programs for Medicare eligible individuals with a range of options for coordinating with the new government-sponsored program to potentially reduce program cost. These options include supplementing the government program on a secondary payer basis or accepting a direct subsidy from the government to support a portion of the cost of the employer’s program.

As the Act was signed into law after the Company’s measurement date (September 30, 2003), any potential financial impact of the Act was not reflected in 2003 results of operations. FASB Staff Position 106-1 allowed the Company to begin recognizing any potential impact of the Act in the first quarter 2004 financial statements or to defer recognizing the potential impact until more definitive accounting guidance is provided. The Company has decided to defer recognition.

Components of the net periodic benefit cost of the Company’s other post-retirement plans for the three months ended March 31, 2004 and March 31, 2003 were as follows:

(1)		Reflects a plan amendment made in January 2004 to eliminate the dental subsidy for all retirees. Refer to Note 14 to the consolidated financial statements presented in Aetna’s 2003 Annual Report on Form 10-K for additional information.
(2)		Reflects plan amendments made in January 2003 related to the phase-out of the retiree medical subsidy for certain employees and elimination of the retiree dental subsidy for certain employees. Refer to Note 14 to the consolidated financial statements presented in Aetna’s 2003 Annual Report on Form 10-K for additional information.

Page 12

13. Segment Information

Summarized financial information for the Company’s principal operations for the three months ended March 31, was as follows:

(1)		Operating earnings (loss) from continuing operations is comprised of income (loss) from continuing operations excluding net realized capital gains, net of tax. While operating earnings (loss) is the measure of profit or loss used by the Company’s management when assessing performance or making operating decisions, it does not replace net income (loss) as a measure of profitability.
(2)		Income from discontinued operations of $40 million for the first quarter of 2004 reflects the completion of certain Internal Revenue Service audits associated with businesses previously sold (former Aetna).

14. Commitments and Contingent Liabilities

Litigation

Managed Care Class Action Litigation

Since 1999, the Company has been involved in purported class action lawsuits that are part of a wave of similar actions targeting the health care payor industry and, in particular, the conduct of business by managed care companies (the “Managed Care Class Action Litigation”).

The Judicial Panel on Multi-district Litigation transferred all of the federal actions, including several actions originally filed in state courts, to the United States District Court for the Southern District of Florida (the “Florida Federal Court”) for consolidated pretrial proceedings. The Florida Federal Court created a separate track for all cases brought on behalf of health care providers (the “Provider Cases”).

Thirteen Provider Cases were presided over by the Florida Federal Court, and a similar action is pending in Louisiana state court, on behalf of purported classes of physicians. These Provider Cases alleged generally that the Company and each of the other defendant managed care organizations employed coercive economic power to force physicians to enter into economically unfavorable contracts, imposed unnecessary administrative burdens on providers and improperly denied claims in whole or in part, and that the defendants did not pay claims timely or did not pay claims at proper rates. These Provider Cases further charged that the Company and the other defendant managed care organizations conspired and aided and abetted one another in the alleged wrongdoing. These actions alleged violations of the Racketeer Influenced and Corrupt Organizations Act, the Employee Retirement Income Security Act of 1974, state unfair trade statutes, state consumer fraud statutes, state laws regarding the timely payment of claims, and various common law doctrines and sought various forms of relief, including unspecified damages, treble damages, punitive damages and injunctive relief.

Page 13

Effective May 21, 2003, the Company and representatives of over 900,000 physicians, state and other medical societies entered into an agreement (the “Physician Settlement Agreement”) settling the lead physician Provider Case pending in the Florida Federal Court. The Physician Settlement Agreement was approved by the Florida Federal Court on November 6, 2003. The order of approval has been appealed to the United States Court of Appeals for the Eleventh Circuit, and the appeal is scheduled to be argued on August 12, 2004. The Company anticipates that, if the approval order is not overturned on appeal, the Physician Settlement Agreement will resolve all pending Provider Cases filed on behalf of physicians that did not opt out of the settlement, including the Louisiana state court action. During the second quarter of 2003, the Company recorded an after-tax charge of $75 million ($115 million pretax) (included in other operating expenses) in connection with the Physician Settlement Agreement, net of an estimated insurance recoverable of $72 million pretax.

A Provider Case brought on behalf of the American Dental Association makes similar allegations on behalf of a purported class of dentists. Effective August 22, 2003 the Company and representatives of approximately 150,000 dentists entered into an agreement (the “Dentist Settlement Agreement”) settling the dentist action. The Dentist Settlement Agreement was preliminarily approved by the Florida Federal Court on April 21, 2004. If finally approved by the Florida Federal Court, the Company anticipates that the Dentist Settlement Agreement would result in the conclusion of all pending Provider Cases filed on behalf of dentists that do not opt out of the settlement. The final approval hearing currently is scheduled for July 20, 2004. The cost of this settlement was not material to the Company.

Three Provider Cases filed in May and June, 2003 on behalf of purported classes of chiropractors and/or all non-physician health care providers also make factual and legal allegations similar to those contained in the other Provider Cases. These Provider Cases have been transferred to the Florida Federal Court for consolidated pretrial proceedings. The Company intends to defend each of these new Provider Cases vigorously.

Securities Class Action Litigation

Laborers Tri-County Pension Fund, Goldplate Investment Partners Ltd. and Sheila Shafran filed a consolidated and amended purported class action complaint (the “Securities Complaint”) on June 7, 2002 in the United States District Court for the Southern District of New York (the “New York Federal Court”). The Securities Complaint supplanted several complaints, filed beginning November 6, 2001, which have been voluntarily dismissed or consolidated. Plaintiffs contend that the Company and two of its current or former officers and directors, William H. Donaldson and John W. Rowe, M.D., violated federal securities laws. Plaintiffs allege misrepresentations and omissions regarding, among other things, the Company’s ability to manage and control medical costs and the appropriate reserve for medical costs as of December 31, 2000, for which they seek unspecified damages, among other remedies. On October 15, 2002, the New York Federal Court heard argument on defendants’ motion to dismiss the Securities Complaint. Defendants intend to continue vigorously defending this action, which is in its preliminary stages.

The Company is unable to predict at this time the ultimate outcome of the Managed Care Class Action Litigation or Securities Class Action Litigation. It is reasonably possible that their outcome, including any negotiated resolution, could be material to the Company. However, as noted above, if the Florida Federal Court’s approval of the Physician Settlement is ultimately affirmed, the Company anticipates that the Physician Settlement Agreement would result in the conclusion of substantially all pending Provider Cases filed on behalf of physicians.

Other Litigation and Regulatory Proceedings

The Company is involved in numerous other lawsuits arising, for the most part, in the ordinary course of its business operations, including employment litigation and claims of bad faith, medical malpractice, non-compliance with state regulatory regimes, marketing misconduct, failure to timely pay medical claims, investing activities, intellectual property and other litigation in its Health Care and Group Insurance businesses. Some of these other lawsuits are or are purported to be class actions.

Page 14

In addition, the Company’s current and past business practices are subject to review by various state insurance and health care regulatory authorities and other state and federal authorities. There continues to be heightened review by these authorities of the managed health care industry’s business practices, including utilization management, delegated arrangements and claim payment practices. As a leading national managed care organization, the Company regularly is the subject of such reviews. These reviews may result in changes to or clarifications of the Company’s business practices, and may result in fines, penalties or other sanctions.

While the ultimate outcome of this other litigation and these regulatory proceedings cannot be determined at this time, after consideration of the defenses available to the Company, applicable insurance coverage and any related reserves established, they are not expected to result in liability for amounts material to the financial condition of the Company, although they may adversely affect results of operations in future periods.

15. Discontinued Operations

Income from discontinued operations of $40 million for the first quarter of 2004 reflects the completion of certain Internal Revenue Service audits associated with businesses previously sold (former Aetna).

Page 15

Independent Accountants’ Review Report

The Board of Directors
Aetna Inc.:

We have reviewed the consolidated balance sheet of Aetna Inc. and subsidiaries as of March 31, 2004, and the related consolidated statements of income, shareholders’ equity and cash flows for the three-month periods ended March 31, 2004 and 2003. These condensed consolidated financial statements are the responsibility of the Company’s management.

We conducted our review in accordance with standards established by the American Institute of Certified Public Accountants. A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with auditing standards generally accepted in the United States of America, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.

Based on our review, we are not aware of any material modifications that should be made to the condensed consolidated financial statements referred to above for them to be in conformity with accounting principles generally accepted in the United States of America.

We have previously audited, in accordance with auditing standards generally accepted in the United States of America, the consolidated balance sheet of Aetna Inc. and subsidiaries as of December 31, 2003, and the related consolidated statements of income, shareholders’ equity and cash flows for the year then ended (not presented herein); and in our report dated February 11, 2004, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying consolidated balance sheet as of December 31, 2003, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.

/s/ KPMG LLP

Hartford, Connecticut
April 28, 2004

Page 16

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis presents a review of Aetna Inc. and its subsidiaries as of March 31, 2004 and December 31, 2003 and its results of operations for the three months ended March 31, 2004 and 2003. This Management’s Discussion and Analysis of Financial Condition and Results of Operation (“MD&A”) should be read in conjunction with the consolidated financial statements and other data presented herein as well as the MD&A contained in the Company’s 2003 Annual Report on Form 10-K.

EXECUTIVE SUMMARY

Aetna Inc. (the “Company”) is one of the nation’s leading providers of health care, dental, pharmacy, group life, disability and long-term care benefits, serving approximately 13.3 million medical members, 11.2 million dental members, 8.1 million pharmacy members and 12.4 million group insurance members as of March 31, 2004. The Company has expansive nationwide provider networks of more than 618,000 health care services providers, including over 370,000 primary care and specialist physicians and 3,783 hospitals. The Company’s operations include three business segments: Health Care, Group Insurance and Large Case Pensions.

The Company’s operating profit in the first quarter of 2004, compared to the first quarter of 2003, reflects continued improvement in the Company’s Health Care business, excluding development of prior period health care cost estimates. This improvement resulted from reductions in general and administrative expenses of $35 million ($54 million pretax) and higher revenue driven by rate increases for renewing membership as well as membership growth for both administrative services contract (“ASC”) business (an employer-funded plan where the plan sponsor assumes all or a majority of the risk for medical and dental care costs) and Risk business (where the Company assumes all or a majority of the risk for medical and dental care costs). While the Commercial Risk medical cost ratio (health care costs divided by premiums) for the first quarter of 2004 increased slightly, reductions in general and administrative expenses, together with these revenue increases, resulted in expanded operating margins. The Company’s medical membership was 13.3 million members at March 31, 2004, representing approximately 34% Risk members and 66% administrative services contract members. The Company continues to take actions designed to achieve membership at December 31, 2004 of approximately 600,000 to 750,000 higher than at December 31, 2003.

The Company continued to generate cash from operations in the first quarter of 2004 which was used to fund, in addition to other operating activities, a $245 million pretax voluntary contribution to its pension plan. The Company also continued purchasing common stock under its share repurchase program.

Summary of Consolidated Results

(1)		Income from continuing operations for the three months ended March 31, 2004 and 2003 reflect favorable development of prior period health care cost estimates of approximately $27 million ($41 million pretax) and $107 million ($164 million pretax), respectively.
(2)		Net income for the three months ended March 31, 2004 includes income from discontinued operations of $40 million related to the completion of certain Internal Revenue Service audits associated with businesses previously sold (former Aetna). Net income for the three months ended March 31, 2004 and 2003 includes net realized capital gains of $17 million and $14 million, respectively.

Page 17

Management Update

Effective April 26, 2004, Louis J. Briskman was named Senior Vice President and General Counsel of the Company, reporting to Chairman and Chief Executive Officer John W. Rowe, M.D. Mr. Briskman was formerly Executive Vice President and General Counsel of CBS Television. He replaces L. Edward Shaw, Jr., who retired, and joins the Office of the Chairman, Aetna’s most senior management group.

Effective April 28, 2004, Craig R. Callen was named Senior Vice President, Strategic Planning and Business Development, a new position, reporting to Chairman and Chief Executive Officer John W. Rowe, M.D. and joins the Office of the Chairman. Mr. Callen was formerly head of U.S. health care investment banking at Credit Suisse First Boston.

Discussion of Segment Results

The discussion of the Company’s results of operations that follows is presented based on the Company’s reportable segments in accordance with Financial Accounting Standard (“FAS”) No. 131, Disclosures about Segments of an Enterprise and Related Information, and is consistent with the disclosure of segment information in Note 13 of Condensed Notes to Consolidated Financial Statements. The measure of profit or loss presented within each segment’s discussion of results of operations is the measure reported to the Chief Executive Officer for purposes of making decisions about allocating resources to the segment and assessing its performance.

HEALTH CARE

Health Care consists of medical and dental plans offered on both a Risk and ASC basis. Health plans include health maintenance organization (“HMO”), point-of-service (“POS”), preferred provider organization (“PPO”) and indemnity benefit (“Indemnity”) products. Health plans also include consumer-directed health plans that combine traditional POS or PPO coverage, subject to a deductible, with an accumulating benefit account.

Operating Summary

(1)		Commercial Risk includes all medical and dental risk products, except Medicare.
(2)		The percentage of health care costs related to capitated arrangements (a fee arrangement where the Company pays providers a monthly fixed fee for each member, regardless of the medical services provided to the member) was 9.6% for the three months ended March 31, 2004 compared to 12.0% for the corresponding period in 2003.
(3)		Includes salaries and related benefit expenses of $482.1 million and $516.5 million for the three months ended March 31, 2004 and 2003, respectively.

Page 18

Results

The table presented below excludes net realized capital gains, although they may recur, from net income to arrive at operating earnings, and reconciles operating earnings to net income reported in accordance with accounting principles generally accepted in the United States of America. Management believes excluding net realized capital gains to arrive at operating earnings provides useful information as to the Company’s underlying business performance. In addition, management uses operating earnings to assess performance and make operating decisions.

Realized capital gains and losses arise from various types of transactions primarily in the course of managing a portfolio of assets that support the payment of liabilities, but these transactions do not directly relate to the underwriting or servicing of products for customers and are not directly related to the core performance of the Company’s business operations. The Company also displays operating earnings and medical cost ratios excluding development of prior period health care cost estimates to better reflect the underlying current period health care costs.